Islamic Finance
Islamic finance refers to commercial banking practices that align with sharia law, which is derived from the Qur'an and Islamic teachings. A key principle of Islamic finance is the prohibition of interest, known as riba, making it morally unacceptable to charge or accept interest on loans. Instead, Islamic banks utilize alternative financing methods such as hibah, which are voluntary gifts representing profit shares, and ijarah, where fixed fees are agreed upon for loans without interest. The framework also includes mechanisms like qard hassan, or benevolent loans, and profit-sharing arrangements such as musharakah and mudarabah to encourage ethical investments and mitigate risk. Islamic finance is becoming increasingly prominent globally, with banks catering to both Muslim and non-Muslim clients. By 2013, Islamic banks had amassed approximately $1.7 trillion in assets, reflecting their rapid growth and the rising interest in sharia-compliant financial products. This financial system aims to provide ethical alternatives to conventional banking while fostering responsible investment practices.
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Islamic Finance
Islamic banking refers to commercial banking activities that are conducted in accordance with Sharia law, or the moral code as derived from the Qur’an and Islamic practices. Islamic banking practices prohibit levying or accepting interest for loans and investing in businesses that are thought to be immoral. It is also required that the quantity, quality, and date of delivery for all services be made explicit in advance of the transaction. Although Islamic banking principles have been in existence for centuries, an increasingly global economy has necessitated the development of privately owned commercial banks for Muslim communities. Reflecting the need and interest of foreign businesses to interact with Muslim communities, non-Muslims have established several major Islamic banks.
Overview
Interest or usury, known in Arabic as riba, is considered a morally offensive, exploitative practice banned by Qur’anic law; as such, it is strictly prohibited in Islamic finance. Instead, Islamic banks often make use of hibah, which is a sum of money given voluntarily from a bank to its customers. The hibah usually represents the customer’s share in profits generated from their bank accounts.
Another alternative to charging and accepting interest is ijarah. Under ijarah, a mutually agreed-upon fixed fee is added to the total amount of the loan. The debtor repays the fee to the bank irrespective of any return on the investment. As there is no risk or interest, it is compliant with Sharia law. Similarly, with qard hassan, or a benevolent loan, the debtor is obliged to remunerate the sum loaned to them. Nevertheless, debtors have the option to pay the lender additional monies as a show of appreciation.
Because of the Qur’an’s prohibition on gambling (maisir) and other high-risk games of chance (gharar), only investment activities with minor risk (yasir) are permissible for Islamic banks. To account for the prohibition of any fees that can be considered excessive or unjustified, Islamic banks and customers agree in advance to fixed fees to provide a profit margin. This practice is a standard part of murabahah (honest declaration of cost) and bai’ bithaman ajil (deferred payment) sales.
A practice specifically adapted to the needs of patrons of Islamic banks is musharakah, or joint ventures. To eliminate the element of high risk, the partners agree in advance to the ratios by which the profits or losses will be shared. Another unique form of partnership in Islamic banking is mudarabah, where one partner invests in a commercial enterprise that is managed by the second partner. If the business generates a profit, it is divided based on a ratio that was mutually and previously agreed on; if the business posts a loss, only the first partner loses their investment.
Early Sharia-compliant banks included the Mit Ghamr Savings Bank, founded in Egypt in 1963, and the Dubai Islamic Bank and the Islamic Development Bank, both established in 1975. By 2013, Islamic banks held an estimated total of US$1.7 trillion in assets, growing at an average annual rate of about 17 percent. By the mid-2020s, Islamic banks held US$3.24 trillion in assets. The most popular Islamic finance institutions included the Kuwait Finance House, Al Rajhi Bank, Boubyan Bank, Abu Dhabi Islamic Bank, and Dukhan Bank.
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